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A Budget baked for rating agencies

27 February 2020 Maarten Ackerman, Chief Economist and Advisory Partner at Citadel
Maarten Ackerman, Chief Economist and Advisory Partner at Citadel

Maarten Ackerman, Chief Economist and Advisory Partner at Citadel

But the proof of the pudding is in the eating

Sparking an immediate celebration in the rand and bond markets, the 2020 Budget Speech ticked all the right boxes for markets, depicting a government that is reform-minded and ready to show its muscles.

First, the numbers placed on the table, while still fairly weak, are slightly better than predicted in last year’s October Medium-Term Budget Policy Statement (MTBPS). And second, government seems ready and willing to action the crucial measures needed to halt the economy’s slide and place it back onto a path of growth.

In an attempt to slow the growth of the ballooning budget deficit and stabilise the country’s fiscal situation, government has proposed cost-cutting measures amounting to R261 billion over the next three years, including a R160.2 billion slash in the bloated public sector wage bill. This, together with the reallocation of funds, is expected to gradually narrow the budget deficit from 6.8% of GDP in 2020/21 to 5.7% in 2022/23, with a debt-to-GDP ratio increasing only slightly to 71.6% within the same period – far better than the sharp slide to 80% we had been warned of in the MTBPS.

Then, in further good news for corporates and households, government surprisingly avoided implementing any significant tax increases aside from some of the usual sin taxes, and particularly avoided the dreaded VAT hike, which should boost consumer and business confidence. Together with a lift in the tax-free threshold for contributions to Tax-Free Savings Accounts (TFSAs) from R33,000 to R36,000 per year, this should provide some especially welcome relief for consumers who have come under significant pressure in the current difficult economic environment.

Additionally, it is worth noting that the fastest growing function over the medium term is spending on economic, community and social development, which is important in terms of fulfilling the country’s social compact.

And finally, on the issue of implementing the necessary reforms at the country’s troubled State Owned Enterprises (SOEs), while R60 billion has been set aside for Eskom and SAA over the medium term, Mboweni explicitly noted that the two parastatals are expected to soon stand on their own two feet without any further funds being siphoned from government coffers.
Together, these measures should be enough to stave off a credit rating downgrade from Moody’s, which is unlikely to push a reform-minded government off the edge of the cliff, so to speak. However, the proof of the pudding is in the eating and it remains to be seen whether government will be able to successfully action its plans.

SA’s back to the wall

South Africa remains on a tightrope and, despite government’s best laid plans, just one slip could completely derail the proposed framework over the next three years and prevent the country from meeting its fiscal targets. Unfortunately, government’s track record on implementation or action has generally been poor. So, while Mboweni has said all the right things, government now needs to do the hard work in delivering or executing its plans.

Without having made the necessary progress on effecting its plans by the time of the 2020 MTBPS, South Africa could again face the risk of a Moody’s downgrade. This is particularly significant given that debt-service costs remain the fastest growing expenditure item on the balance sheet, and that a downgrade would take even more money away from crucial areas such as education, health and social grants in favour of interest payments.

The four key risks to government’s plans

There are essentially four major risks that threaten the Budget framework:

1. Weak growth:

While forecasted economic growth of 0.9% is realistic, the risk of persistent low economic growth is significant given that South Africa has consistently had to adjust its growth forecasts downwards over the past few years, placing pressure on revenue collection targets. This is made especially acute by geopolitical risks that threaten to hamper growth, such as the Coronavirus. Furthermore, the global growth landscape, which SA depends on considerably, is likely to change from a tail wind into a headwind over the next few years.

2. The Public Sector Wage Bill:

The reality is that if government doesn’t cut back on the size of the public sector wage bill by October, it will not be able to meet its expenditure reduction targets. This in turn will threaten its commitment to halting its rising debt-levels and narrowing the budget deficit, placing the country at real risk of falling into an unsustainable debt-trap.

COSATU’s reaction to the Budget Speech further suggests that labour unions will not make it easy for government to action the necessary cost-cutting and successfully renegotiate wage agreements. However, government successfully saw off SAA in its strike in November last year, setting a new foundation for union relations and potentially undermining union power.

3. Eskom:

Eskom’s decaying infrastructure and crippling debt levels mean that it is currently unable to supply the generating capacity needed to support growth of above 3%, strangling the economy’s growth prospects.

4. The Road Accident Fund:

The RAF’s liabilities are growing at an unsustainable rate, expected to exceed R600 billion by 2022/23. To put this in perspective, Eskom’s debt levels are currently around R450 billion. The RAF’s liabilities constantly exceed its income, and represent a significant threat to government’s cost-containment measures, placing the fiscus at serious risk.

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